STRATEGIC COST

MANAGEMENT
Cost Concepts, Classifications, and
Cost Behavior
At the end of discussion,
you should be able to:

Explain cost accounting and

the importance of cost
information.
At the end of discussion,
you should be able to:

Differentiate manufacturing and

manufacturing costs, product and
period costs, direct and indirect cost,
and controllable and incontrollable
cost.
At the end of discussion,
you should be able to:

Describe what relevant

range is and distinguish
three cost behavior-fixed,
variable, and mixed.
At the end of discussion,
you should be able to:

Apply separation of mixed

costs using different methods
in managerial planning and
controlling.
At the end of discussion,
you should be able to:

Describe all other relevant

costs that affect managerial
planning, controlling and
decision making.
 COST
A cost reflects the amount of resources
sacrificed in order for the company to
achieve a certain objective such as
creation of goods or rendering of services
in order to earn re venues.
 COST

A service provider needs to purchase

supplies and materials, and pay
salaries to employees in order to
render service and earn revenues.
 COST

A merchandiser has to first

purchase the goods that they
need to sell in order to earn
revenues.
 COST
A manufacturer spends for materials,
labor payroll, and other factory
burden to transform raw materials to
finished goods and eventually sells
those goods to earn revenues.
Cost on a managerial emphasis
Cost information coming from cost accounting is a vital tool in order for managers to plan and
control operations effectively. This stresses the need for timely and relevant cost information.
• Cost analysis and management should come after making cost information available.
• Techniques like budgeting and forecasting helps the entity plan the future and subsequently control
operations through performance evaluation and variance analysis when actual data becomes
available.
• Generally, a manager would have to think of ways in order to reduce costs and other expenses on the
standpoint of increasing profits. Strategically however, increases or decreases in cost should support
the strategic positioning set by the entity – basically referring on how to achieve competitive
advantage.
• On a strategic management standpoint, management functions, cost management, planning and
decision making should be in line with the entity’s vision, mission, goals, and objectives.
• Cost management and control is highly important factor in achieving, maintaining, and growing the
entity’s profitability.
• When an entity is continuously profitable, value continuously increases, which goes back to the
importance of the alignment of cost control with the entity’s vision and mission. A manager should
always put cost management in mind on a strategic standpoint.
Cost based on functional areas

Manufacturing Cost Nonmanufacturing Cost

Cost that is incurred in the entity’s Cost that is incurred in the entity’s operations on
operations on producing products and making the product known, selling them, and
services. other administrative expenses.
• Direct materials • Operating expenses
• Direct labor
• Manufacturing overhead • What can we do to eliminate other operating

• How can we lower down our costs of

production?
VS expenses that does not add value to the
company?
• Are there other expenses we need to consider
• What is the standard labor hours in the
production of Product A?
• How many units of Material X shall we
. that could help in our operations?
• Our office rent increased this month as
compared to last month.
purchase next period to avoid production
delays?
Cost based on timing of matching with revenues

Product Cost Period Cost

Cost assigned to products until they are sold. Costs incurred and recognized based on time
 periods.
Goods not yet completed-WIP inventory
 Operating expenses
 Goods completed-FG inventory
 Goods sold- Cost of goods sold

 Is there a proper segregation of payroll as to

 What are the costs that we included as product

costs that, in turn, an inventoriable cost, and
VS 
laborers and payroll as to office staff?
Is there a proper segregation of factory

.
facility rent and office rent?
becomes cost of goods sold when sold to
customers?  What costs shall be reviewed that should be
included as product costs rather than as
period costs and vice-versa?
Cost Traceability

Direct Cost Indirect Cost

Cost that are traceable to a particular product line, Costs that are not directly traceable to a
segment, department, division, or branch. particular product line, segment, department,
division, or branch.

 Assuming an entity reviews all costs incurred in

a specific department, all material and labor  If all product lines has only one production
costs identified in that department are direct
costs. Salaries of supervisors in that
department is still a direct cost in that certain
VS head, the salary of the production head will
be allocated to the different product lines,
which makes it indirect. However, the salary

.
department (because its traceable there). of the production head is still a direct cost if
we will be talking about the whole
production department.
Cost controllability

Controllable Cost Uncontrollable Cost

Cost that can be influenced by the manager on how Costs that are not directly traceable to a
it will be incurred and can be altered in the short particular product line, segment, department,
run. division, or branch.
 Power or authority to incur costs.  Allocated to the department under his
 leadership.
Manager has freedom to set levels and decide
for price, quality, and quantity, and even the  Costs incurred traceable to the specific
supplier of materials and other inputs. department but is incurred because it is

 Direct materials and direct labor

VS decided by the higher authority or
management.



Donations and other contributions
Training costs
. 

Depreciation
Insurance
 bonuses  Allocated overhead
 Allocated rent
Costs as to decision making
Opportunity Cost

These are the benefits forgone in choosing one

alternative over the other course of action.
 Spending for a cheeseburger for P50 per day for
the next ten years would have accumulated to
P182, 500 worth of saving if you chose to save.
 An entity has chosen to rent a facility. The
payment for the rent could have been spent on
other aspects of the operations of business.
Costs as to decision making
Differential Cost

Differences of costs under alternative actions or

decisions.
 Incremental or decremental costs or profits (losses
in deciding whether to make or buy, shut down or
continue, sell as is or process further, and drop a
product line or not.
Costs as to decision making
Relevant Cost

Differences of costs under alternative actions or

decisions.
 Incremental or decremental costs or profits (losses
in deciding whether to make or buy, shut down or
continue, sell as is or process further, and drop a
product line or not.
Costs as to decision making
Marginal Cost
Extra cost incurred when one additional unit is
produced. It determines the quantity most
efficient to produce.
 Marginal cost production is an important
concept in managerial accounting, as it can help
an organization optimize their production.
 Fixed costs are constant regardless of
production levels, so higher production leads to
a lower fixed cost per unit as the total is
allocated over more units.
 Variable costs change based on production
levels, so producing more units will add more
variable costs.
Costs as to decision making
Average Cost per unit
Total cost to produce divided by the
total number of units manufactured.

Variable cost P40 per unit

Fixed cost P5,000
Total Total fixed Total cost Average cost
variable cost per unit
cost

At 1,000 units 40,000 5,000 45,000 45

5,000
At 2,000 units 80,000 85,000 42.50

5,000
At 3,000 units 120,000 125,000 41.67
Costs as to decision making
Out-of-pocket Cost

Costs or expenses that require a cash payment in

the current period or during a project.
 The wages of the person setting up a machine for
a new production run are an out-of-pocket cost.
However, the cost of the lost opportunity to be
producing profitable output during the setup time
is not an out-of-pocket cost.
 Payment of rent, wages, or interest.
Cost Behavior

How a cost will respond according to

changes in the production process or
level of activity.
Relevant Range

The range of production activity that

presents the entity’s normal
operating levels where relationships
of cost behaviors are deemed
acceptable.
 Cost Behaviors

Variable Cost Fixed Cost

They are costs that change as the quantity of the At whatever level of production within the
goods produced changes. Total amount of relevant range, this cost does not change. It
variable costs is dependent to the level of is independent of the level of production.
production.

Examples: Examples:
• Costs of materials • Rent of facilities
• Cost of direct labor computed per hour • Depreciation of equipment
 Cost Behaviors
Variable Costs Fixed Costs
• Constant on a per-unit basis. • Constant when presented as a total
• Varies when presented as a total. • Varies on a per-unit basis
Assume an entity’s normal manufacturing process with a range of 5,000 to 7,000 units of goods with a
variable cost per unit of P20 and P15,000 fixed costs.

VC/ unit Total variable costs Fixed costs FC/unit

At 5,000 units P20 P100,000 At 5,000 units P15,000 P3.00
At 6,000 units P20 P120,000 At 6,000 units P15,000 P2.50
At 7,000 units P20 P140,000 At 7,000 units P15,000 P2.14
 Cost Behaviors

Cost Equation How much is the total cost to

manufacture products with a variable
y = a + bx manufacturing cost per unit of P 25 and
total manufacturing fixed cost of
y = total cost P40,000 at the following production
a = total fixed cost levels:
b = variable cost per unit a. 2,000 units
x = volume of activity b. 4,500 units
c. 7,250 units
 Cost Behaviors
𝑦 =𝑎+𝑏𝑥
How much is the total cost to 𝑦 =40,000+(25)(2,000)
manufacture products with a variable 𝑦 =40,000+50,000
manufacturing cost per unit of P 25 and 𝑦 =90,000
total manufacturing fixed cost of 𝑦 =𝑎+𝑏𝑥
P40,000 at the following production 𝑦 =40,000+(25)(4,500)
levels: 𝑦 =40,000+112,500
a. 2,000 units 𝑦 =152,500
𝑦 =𝑎+𝑏𝑥
b. 4,500 units 𝑦 =40,000+(25)(7,250)
c. 7,250 units 𝑦 =40,000+181,250
𝑦 =221,250
 Cost Behaviors

Mixed Cost Step Cost

Refers to costs that has both variable anf fixed Costs that are constant on a certain level of
components. activity but increases on another certain level
of activity.

Examples:
• Utilities and maintenance costs, since these Examples:
are charged or is incurred with a base • Salaries and commission of agents that goes
amount and goes higher with any usage over higher with different ranges of activity e.g.
the base amount. people or customers served.
 Separation of Mixed Costs
It might be difficult for managers to be able to plan, control, or make a
decision when the set of cost information has mixed costs. Therefore, it will
be helpful in managerial decision making to be able to see both the variable
cost and fixed cost component in a set of observations. Therefore, there are
three methods to be employed in separating mixed costs:
• High-low method
• Least squares regression method
• Scatter diagram
 High – low Method
Dahyun Company builds tabletop replicas of some of the famous tourist attractions in Seoul. The company is highly
automated where maintenance costs shows as a significant expense. The owner decided to use machine hours as the
basis of predicting maintenance costs and has gathered the following data for the following eight weekly operations:

Week Machine hours Maintenance cost

1 3,000 P 9,800
2 4,500 12,900
3 8,000 18,100
4 6,000 13,500
5 9,000 24,800
6 3,500 10,400
Using the high-low method, determine the following: 7 5,500 13,000
a. Variable cost per unit 8 7,000 16,000
b. Total fixed cost
c. Total expected maintenance cost on 8,200 machine
hours.
 High-low Method
Step 1: Determine the highest and lowest activity and the costs associated thereunto.

Week Machine hours Maintenance cost

1 3,000 P 9,800
2 4,500 12,900
3 8,000 18,100
4 6,000 13,500
5 9,000 24,800
6 3,500 10,400
7 5,500 13,000
8 7,000 16,000
 High-low Method
Step 2 : Obtain the variable cost per unit by dividing the change in cost over the change in
activity.

Week Machine hours Maintenance Cost highest activity-Cost at lowest activity

cost VC /unit=
Highest activity-lowest activity
1 3,000 P 9,800
P24,800-9,800
2 4,500 12,900 VC /unit=
9,000mh-3,000mh
3 8,000 18,100
4 6,000 13,500 P15,000
VC /unit=
5 9,000 24,800 6,000mh
6 3,500 10,400
7 5,500 13,000 VC /unit= P2.50 per machine hour
8 7,000 16,000
 High-low Method
Step 3 : Obtain the total fixed costs by removing the variable cost component in the total costs.

Highest activity Lowest activity

Total costs P24,800 P9,800
Less:Variable cost component
High 9,000mh x P2.50/mh 22,500
Low 3,000mh x P2.50/mh
Fixed cost 7,500
P2,300
P2,300
 High-low Method
How much is the total maintenance cost at 8,200 machine hours?

y = a + bx
y = 2,300 + (2.50)(8,200)
y = 2,300 + 20,500
y = 22,800
 Least Squares Regression Method
Dahyun Company builds tabletop replicas of some of the famous tourist attractions in Seoul. The company is highly
automated where maintenance costs shows as a significant expense. The owner decided to use machine hours as the
basis of predicting maintenance costs and has gathered the following data for the following eight weekly operations:

Week Machine hours Maintenance cost

1 3,000 P 9,800
2 4,500 12,900
3 8,000 18,100
4 6,000 13,500
5 9,000 24,800
6 3,500 10,400
Using the high-low method, determine the following: 7 5,500 13,000
a. Variable cost per unit 8 7,000 16,000
b. Total fixed cost
 Least Squares Regression Method
Step 1: Prepare a table calculating x (activity), y (total cost), xy, and .

x y xy
3,000 9,800 29,400,000 9,000,000
4,500 12,900 58,050,000 20,250,000
8,000 18,100 144,800,000 64,000,000
6,000 13,500 81,000,000 36,000,000
9,000 24,800 223,200,000 81,000,000
3,500 10,400 36,400,000 12,250,000
5,500 13,000 71,500,000 30,250,000
7,000 16,000 112,000,000 49,000,000
SUM 46,500 118,500 756,350,000 301,750,000
Where n = 8
 Least Squares Regression Method
Step 2 : Substitute the computed amounts in the following equation to get VC/unit.

𝑦 =𝑎 +𝑏𝑥

∑ 𝑦=𝑛𝑎+𝑏∑ 𝑥
∑ 𝑥𝑦=∑ 𝑥 𝑎+𝑏 ∑ 𝑥 2
 Least Squares Regression Method
Step 2 : Substitute the computed amounts in the following equation to get VC/unit.

x y xy 118,500 = 8a + 46,500b
SUM 46,500 118.500 756,350,00 301,750,00 756,350,000 = 46,500a + 301,750,000b
0 0
Where n=8
-46,500( 118,500 = 8a + 46,500b )
8( 756,350,000 = 46,500a + 301,750,000b )

∑ 𝑦=𝑛𝑎+𝑏∑ 𝑥 -5,510,250,000 = -372,000a - 2,162,250,000b

6,050,800,00 = 372,000a + 2,414,000,000b

540,550,000 = 251,750,000b

∑ 𝑥𝑦=∑ 𝑥 𝑎+𝑏 ∑ 𝑥 2
b
=

= 2.15
 Least Squares Regression Method
Step 3 : Substitute b to any equation to get a (fixed cost).

b = 2.15 118,500 = 8a + 46,500b

756,350,000 = 46,500a + 301,750,000b

118,500 = 8a + 46,500b
118,500 = 8a + 46,500(2.15)
118,500 = 8a + 99,975
-8a = -118,500 + 99,975
-8a = -18,525
=
a = 2,315.63
 Let’s compare
HLM LSRM
Variable cost per
unit P2.50 P2.15
Total fixed cost P2,300 P2,315,63
 Scatter Diagram
Scatter diagram Method is a graphical technique of
separating fixed and variable components of mixed
cost by plotting activity level along x-axis and
corresponding total cost(i.e. mixed cost) along y-axis.
• A regression line is drawn on the graph by visual
inspection.
• The line thus drawn is used to estimate the total
fixed cost and variable cost per unit.
• The point where the line intercepts y-axis is the
estimated fixed cost and the slope of the line is the
average variable cost per unit.
• Since the visual inspection does not involve any
mathematical testing, therefore, this method
should be applied with great care.
 Scatter Diagram
Example
Company a decides to use scatter graph method to split its factory overhead (FOH) into variable
and fixed components. Following is the data which is provided for the analysis.
Month Units FOH
1 1,520 $36,375
2 1,250 38,000
3 1,750 41,750
4 1,600 42,360
5 2,350 55,080
6 2,100 48,100
7 3,000 59,000
8 2,750 56,800
 Scatter Diagram
Step 1: Draw scatter graph
Plot the data on scatter graph. Plot activity level along x-axis and total
mixed cost along y-axis.
Month Units FOH Step 2: Draw regression line
1 1,520 $36,375 Draw a regression line over the scatter graph by visual inspection and try to
minimize the total vertical distance between the line and all the points.
2 1,250 38,000 Extend the line towards y-axis.
3 1,750 41,750 Step 3: Find total fixed cost
Total fixed is given by the y-intercept of the line. Y-intercept is the point at
4 1,600 42,360 which the line cuts y-axis.
5 2,350 55,080 Step 4: Find variable cost per unit
Variable cost per unit is equal to the slope of the line. Take two points ( )
6 2,100 48,100 and ( ) on the line and calculate variable cost using the following formula:
7 3,000 59,000
Variable Cost per unit
8 2,750 56,800 =Slope of regression line
=
 Scatter Diagram
Month Units FOH
1 1,520 $36,375
2 1,250 38,000
3 1,750 41,750
4 1,600 42,360
5 2,350 55,080
6 2,100 48,100
7 3,000 59,000
8 2,750 56,800

Fixed Cost = y-intercept = $18,000

Variable Cost per unit = Slope of regression line
To calculate slope we will take two points on line: (0,18000) and (3500, 68000)
Variable Cost per unit = (68000-18000)/(3500-0)= $14,286
Thank you!
 ASSIGNMENT
Answer the following using your own words.
• Explain cost accounting and the importance of cost information.
• Differentiate manufacturing and manufacturing costs, product and period
costs, direct and indirect cost, and controllable and incontrollable cost.
• Describe what relevant range is and distinguish three cost behavior-fixed,
variable, and mixed.
• Describe all other relevant costs that affect managerial planning,
controlling and decision making.